A lot of real estate investors start out struggling with a lack of capital – this can be really discouraging and can make the barrier to entry for real estate investing seem much bigger than it really is. In this article, I am going to tell you about what the FHA 203(k) loan is and why you should be using it for your real estate business in 2021 and beyond.
FHA 203(k) Loan – Figuring Out What You’re Trying to Buy and How It Fits
I was there myself at one time – struggling to stay motivated while home prices were sky-rocketing (ironic now in 2021) all whilst trying to save for my first duplex. I intended to owner occupy, or “House Hack” as I’m sure you have heard discussed on Bigger Pockets. I also wanted to implement the BRRRR method coined by David Green and Brandon Turner to buy a distressed property, fix it up and create a higher After Repair Value (“ARV”) so I could refinance my cash out and do another one as quickly as possible.
… Sound familiar?
Let’s recap the above but organize the information in a different way. The Investor needs a loan that will allow them to use a low down-payment to purchase a property, needs money to rehab a property and doesn’t intend to keep that specific loan product long term. This scenario works perfectly for the FHA 203(k) Loan.
Let me tell you why!
FHA 203(k) Loan – What Is It? Explained in Plain English
An FHA loan is a low down-payment loan offered for low-income or low-credit score borrowers who are looking to purchase a primary residence and need assistance in the form of lower interest rates and down payments. The “203(k)” subset of that product allows for additional funds to be borrowed to rehabilitate a property that needs extensive work so that the buyer can occupy a safe house that won’t need tons of expensive repairs after the work is completed.
How good does this sound right now?
If you’re really excited about using an FHA 203(k) loan to buy your first, or next property you should be!
The bank is willing to lend you the purchase price of the property plus the cost of the estimated repairs that need to be completed by a certified General Contractor. Once the property is fixed up you can now move into your new primary residence and refinance in as little as 6 months into a less expensive loan (we’ll cover that below).
Okay, so now we know what the FHA 203(k) loan is and have an idea of how it works into our investment strategy, but we also need to consider a few other factors.
FHA 203(k) Loan – MIP VS PMI
FHA Loans, in general, have something called Mortgage Insurance Premium (“MIP”). Note that this is different than Private Mortgage Insurance (“PMI”) on traditional loans.
What’s the difference?
MIP does not ever leave the loan while PMI can be removed from your loan once you hit a certain equity percentage or in some cases a certain time period. Definitely keep this in mind when considering long-term cash flow if you do not want to refinance or rates go up.
In addition, you will also need to pay something called Up Front Mortgage Insurance Premium (“UFMIP”) which is about less than a percentage point of the purchase price plus rehab costs being borrowed. This can be expensive when you have little capital starting out and the cash paid does not go towards your equity.
FHA 203(k) Loan – Paperwork & Headaches!
Nothing in life is free and the FHA 203(k) loan is no different! When using the FHA or FHA 203(k) loan as a real estate investor, you need to understand that there will be a lot of paperwork and a lot of headaches. Period.
This loan product requires a licensed General Contractor with insurance before you close with a detailed scope of work on what you plan to do with the property. You will also need a 203(k) consultant to prepare an independent scope of work and compare that with your GC to make sure that the prices are reasonable compared to market and you’re not getting gouged.
Once you’re in the Rehab process, that consultant will have to come out and inspect the work before the bank will pay the General Contractor so be prepared for that to be a pain in the you know what.
FHA 203(k) Loan – Final Thoughts
While this article is not a comprehensive guide on using an FHA 203(k) loan to invest in real estate, it still shows you what a 203k loan is, why you want to have it in your real estate investor toolbelt and some of the good and not so good when using it!
Now get out there and start finding deals!